Imagine looking up at seven cents on the dollar.
That's what the holders of Greater Atlantic Financial Corp.'s trust-preferred shares are doing. In lieu of outright failure, the Reston, Va., thrift is preparing to sell itself to a private-equity firm. But before it can close the sale, Greater Atlantic must buy back the vast majority of its $9.6 million of trust-preferred shares — at a 93% discount. Observers said that, faced with a wipeout otherwise, trust-preferred holders might well accept the deal.
The trust-preferred tender offer is unusual, but could become common practice as more distressed companies strike last-minute deals to prevent failure, experts say.
"I haven't seen this in a deal yet, but we've thought of it, too. So to the extent that we see distressed companies with trust-preferred shares, I wouldn't be surprised if this doesn't become a fairly common pattern," said Kenneth E. Kohler, a partner at Morrison & Foerster LLP. "We have advised clients that this type of requirement should not be unexpected."
That's because trust-preferreds are a form of debt, and buyers want as little debt on the balance sheet as possible, Kohler said.
For the security holders, a steeply discounted payoff "is actually a pretty appealing proposition opposed to the alternative," he said. "They would get nothing if it failed."
Should Greater Atlantic's deal with MidAtlantic Bancorp Inc. collapse, regulators could seize Greater Atlantic's $219 million-asset thrift.
Last month regulators ordered Greater Atlantic to quickly raise capital. It found a savior in MidAtlantic, which agreed to pay 10 cents a share, or $300,000, for Greater Atlantic, and to invest up to $15 million to recapitalize the thrift. MidAtlantic, which was set up by the Virginia investment firm Comstock Partners LC, would become a thrift holding company after the acquisition.
Greater Atlantic issued $9.6 million of trust-preferred securities in March 2002, and has deferred the 6.5% interest payments on the shares since December 2006. Under the deal agreement, 85% of the 963,038 shareholders must agree with the tender offer. The company is not allowed to pay them more than $688,558 total.
The agreement did not give a timetable for the tender offer, nor did it say how Greater Atlantic intends to fund the payout. Calls to the thrift and the private-equity firm were not returned.
Kohler said that this trust-preferred action has a better chance of success than the attempt CIB Marine Bancshares Inc. made earlier this year to restructure its trust-preferred securities into traditional preferred shares. This time, he said, not all the trust-preferred shareholders have to approve the offer, and Greater Atlantic is in worse shape than CIB. (CIB's trust-preferred shareholders rejected its proposal in May and the company said last month that it was preparing a modified proposal.)
Eric Luse, a partner at Luse Gorman Pomerenk & Schick PC who represented Greater Atlantic, said that its sale to MidAtlanticwould be beneficial to everyone involved. "If the deal gets done, it provides an investment opportunity for the investors, it preserves Greater Atlantic and there is some value for the stockholders," Luse said. And any time regulators can avoid losses to the deposit insurance fund, "that is always a better deal for everyone."
Michael Iannaccone, the president of MDI Investments in Chicago, said it is conceivable that "the trust-preferred shareholders could play chicken and ask for a better deal." But, he added, "I would settle. They don't have a lot to bargain with, and it would be extremely risky. The investor group could just walk away and find another bank. There is no shortage in supply of banks that need capital."
Still, Iannaccone said, since trust-preferred shares count toward Tier 1 capital and are cheaper to issue than common shares, some distressed sellers may try to avoid making such tender offers.
Greater Atlantic has been operating under a cease-and-desist order from the Office of Thrift Supervision since April 2008. On May 22 of this year the OTS gave it 10 days to find a way to bring its total risk-based capital ratio to 8% and its Tier 1 risk-based and leverage ratios to 4% or face seizure. At March 31, the end of its second quarter, the bank's total risk-based capital ratio was 5.98%, its Tier 1 risk-based capital was 4.84%, and its leverage ratio was 3.22%.
Karen Dorway, the president of BauerFinancial Inc., a bank rating firm in Coral Gables, Fla., said Greater Atlantic is also sitting on $6.4 million of unrealized losses on securities. Should the bank be forced to recognize those losses, its total risk-based capital ratio would drop to 0.36%.
The company has lost $3.9 million in the first six months of its fiscal year, which began Oct. 1. It also lost $10.9 million in its fiscal 2008, its fifth annual loss in the past six years.
"Delinquent loans are not really all that high for them," said Dorway, whose firm has given Greater Atlantic zero stars, its lowest rating. However, it appears that the company has been dealing with credit problems for at least a year and a half. Noncurrent loans made up 3.23% of total loans at March 31, compared with 1.42% a year earlier. In the first six months of its year the company's provision for loan losses was $2.7 million, down 3.5% from a year earlier. In its fiscal 2008, the provision totaled $3.4 million, up fivefold from fiscal 2007.
Dorway said that it would take $10 million to $15 million to return the bank to traditional well-capitalized standards and protect it from the unrealized losses.
MidAtlantic has said it would use the acquisition as a linchpin to build a larger banking company.
"We are excited about the prospects of continuing the Greater Atlantic Bank franchise as we build a premier community bank for the Washington Metro area," said MidAtlantic's president, Gary L. Martin, in the June 17 press release announcing the deal.
Greater Atlantic has been trying to sell itself since at least April 2007, when it struck a deal with Summit Financial Group Inc. in Moorefield, W.Va., for $18.2 million. That deal was called off a year later. It was resurrected in June 2008 in a deal valued at $12.1 million. The second attempt to merge with Summit was terminated in December.
